1. Network Hubs vs. Point-to-Point, Is There a Problem? Robert J. Gordon Northwestern University Airline Economics Seminar, April 7, 2004

2. “The Basic Business Model of the Network Carriers is Broken” “They will have to reinvent themselves or go out of business” Why? “They will have to reinvent themselves or go out of business” Why? WN, B6, FL have 30% cost advantage WN, B6, FL have 30% cost advantage Non-unionized workforce Non-unionized workforce Better business practices Better business practices Selling most tickets over internet Selling most tickets over internet Higher utilization, shorter turns, no waiting at hubs, B6 redeyes Higher utilization, shorter turns, no waiting at hubs, B6 redeyes Capacity share of LCCs in domestic U. S. is rapidly approaching 1/3 Capacity share of LCCs in domestic U. S. is rapidly approaching 1/3

3. The Indictment of Hubs (Economist, 3/27/04) LCCs LCCs Simple point to point Simple point to point No transfers, no baggage transfer, no lounges No transfers, no baggage transfer, no lounges Charge for food and drink Charge for food and drink Network carriers Network carriers Planes sit around for a long time waiting for connections Planes sit around for a long time waiting for connections Flight crews hang around, ground staff hang around Flight crews hang around, ground staff hang around Key flaw, budget airlines turn a plane around in 25 minutes while “it takes 90 minutes for a jumbo” Key flaw, budget airlines turn a plane around in 25 minutes while “it takes 90 minutes for a jumbo”

4. Some Observers have Predicted for a Decade that the future is point-to- point, the Network Hub is Doomed Why? Why? Naïve observers mesmerized by the inexorable advance of Southwest Naïve observers mesmerized by the inexorable advance of Southwest Yes, Yes, Southwest dominates short-haul point-to-point in markets where they compete. BWI, DAL, HOU Southwest dominates short-haul point-to-point in markets where they compete. BWI, DAL, HOU Oops, “dominance” is not true when a hub carrier is on either end Oops, “dominance” is not true when a hub carrier is on either end UA at SFO vs. WN at OAK UA at SFO vs. WN at OAK UA at ORD vs. WN at MDW UA at ORD vs. WN at MDW HP at PHX vs. WN at PHX HP at PHX vs. WN at PHX

5. WN’s Expansion has created A Hub and Long-haul Carrier Southwest is now a major hub and long-haul carrier. It supports its own flying by one-stops and connections through: Southwest is now a major hub and long-haul carrier. It supports its own flying by one-stops and connections through: LAX, PHX, HOU, DAL, SLC, MCI, MDW, BNA, BWI LAX, PHX, HOU, DAL, SLC, MCI, MDW, BNA, BWI For WN’s build-up at BWI, connecting is essential For WN’s build-up at BWI, connecting is essential Does WN’s operational difference in operating a hub predict a major change for network legacies? Does WN’s operational difference in operating a hub predict a major change for network legacies? WN planes turn in 25 minutes at hubs WN planes turn in 25 minutes at hubs Passengers wait for the connection, the planes don’t wait for the passengers. Many waits are 2 hours+ Passengers wait for the connection, the planes don’t wait for the passengers. Many waits are 2 hours+

6. Even constrained to the American Landscape, LCC’s ≠ Point-to-Point Not just the evolution of WN into a hub carrier Not just the evolution of WN into a hub carrier Look at the successful LCCs which operate a core, old-line, network hub operation Look at the successful LCCs which operate a core, old-line, network hub operation Air Tran at ATL Air Tran at ATL Frontier at DEN Frontier at DEN JetBlue is different JetBlue is different Huge local market at JFK Huge local market at JFK No need to connect, can fill planes with local No need to connect, can fill planes with local Connecting is gravy, so far upstate NY and BTV Connecting is gravy, so far upstate NY and BTV

7. How Can a Network Carrier Make Money Against a Massive LCC Attack? No network carrier more under assault than BA No network carrier more under assault than BA RyanAir, EasyJet operate most of their capacity ex-Luton, Stansted, etc. to Europe RyanAir, EasyJet operate most of their capacity ex-Luton, Stansted, etc. to Europe “The European market is going the same way as U. S. but it is all happening much faster” (Economist) “The European market is going the same way as U. S. but it is all happening much faster” (Economist) Aviation Strategy: LCC account for 33% of UK domestic capacity, 33% UK-Europe Aviation Strategy: LCC account for 33% of UK domestic capacity, 33% UK-Europe Surely BA is reeling from this attack, on its knees? Surely BA is reeling from this attack, on its knees?

8. Surprise! BA is not on its Knees BA: Predicted to make $1.1 billion profit (£600) in year ending March 2004, despite SARS! BA: Predicted to make $1.1 billion profit (£600) in year ending March 2004, despite SARS! Emerging from recession and SARS, AF and LH are also highly profitable Emerging from recession and SARS, AF and LH are also highly profitable Why are Big European hub carriers successful despite the LCC invasion? Why are Big European hub carriers successful despite the LCC invasion?

9. British Airways, what’s the secret? $1.1 billion profits in past year $1.1 billion profits in past year The MOST affected of all European airlines by LCCs. The MOST affected of all European airlines by LCCs. Ryanair, $9 to Barcelona, Charleroi, Pescara, Bergamo Ryanair, $9 to Barcelona, Charleroi, Pescara, Bergamo Easyjet to major competing airports like AMS Easyjet to major competing airports like AMS Yet major European hub network carriers are not battling for the traffic from Luton to Pescara Yet major European hub network carriers are not battling for the traffic from Luton to Pescara

10. How European Hub Carriers Differ, Can we Count the Ways? Decades of Fighting the Charter Carriers Decades of Fighting the Charter Carriers B6 15*JFK-FLL B6 15*JFK-FLL Germany? Urlaubsflüge Germany? Urlaubsflüge 5*daily Paderborn/Lippstadt to Majorca 5*daily Paderborn/Lippstadt to Majorca Many others all over the Mediterranean from Tenerife to Rhodes Many others all over the Mediterranean from Tenerife to Rhodes More still from Hamburg, Berlin, Dusseldorf More still from Hamburg, Berlin, Dusseldorf These are on carriers you never heard of: Air Berlin, Condor These are on carriers you never heard of: Air Berlin, Condor Britain? The same, “bucket shops” Britain? The same, “bucket shops”

11. More Ways Europe is Different Decades of Fighting the High-speed Train Decades of Fighting the High-speed Train Most Important France, then Germany and NL, least important Britain Most Important France, then Germany and NL, least important Britain Less VFR Travel Less VFR Travel Ryanair takes people to French villages (Pau) where they don’t know anyone Ryanair takes people to French villages (Pau) where they don’t know anyone Not Like U. S. where everyone has relatives everywhere Not Like U. S. where everyone has relatives everywhere Ryanair, Easyjet are creating travel that didn’t exist before, not just diverting from BA Ryanair, Easyjet are creating travel that didn’t exist before, not just diverting from BA

12. European Network Carriers do what they do best, NETWORK! Misguided financial analysis, heard for years Misguided financial analysis, heard for years “BA makes all its money on its intercontinental network, loses money in Europe” “BA makes all its money on its intercontinental network, loses money in Europe” BUT BA could not have that intercontinental network without backup from Europe BUT BA could not have that intercontinental network without backup from Europe Poor cost and revenue accounting Poor cost and revenue accounting A network is a network, you can’t unravel it A network is a network, you can’t unravel it Pan Am in the late 1980s was the opposite Pan Am in the late 1980s was the opposite By never becoming dependent on charter, rail, VFR traffic, European airlines do what they do best By never becoming dependent on charter, rail, VFR traffic, European airlines do what they do best

13. BA and LH,Where are they Flying? (no code-shares, explain) LHRLGWFRAMUC Domestic 48418580 Western Europe 13062138108 Eastern Europe 1502719 Middle East 100114 Africa 10071 Asia 100133 North America 355253 Latin America 3430 Total 261112309218 # not Dom/WE 8398630 % not Dom/WE 3282814

14. Contrast with U. S. Network Carriers Even the Most International of the U. S. Network carriers don’t match BA or LH Even the Most International of the U. S. Network carriers don’t match BA or LH UA: UA: 13 international wide-body departures each from SFO, ORD, IAD 13 international wide-body departures each from SFO, ORD, IAD ORD: 13 out of 620, barely 2% ORD: 13 out of 620, barely 2% Smaller planes (DL) Smaller planes (DL) More dependence on Florida, LAS, PHX, prime territory for LCCs, would have been charter decades ago in Europe More dependence on Florida, LAS, PHX, prime territory for LCCs, would have been charter decades ago in Europe

15. Other Accusations at Networking “New Longer-range planes undermine dominance of hubs in many regions” “New Longer-range planes undermine dominance of hubs in many regions” Does SQ flying SIN-LAX undermine any hub or just strengthen SIN and LAX as hubs? Does SQ flying SIN-LAX undermine any hub or just strengthen SIN and LAX as hubs? Does EW flying DXB-ORD undermine any hub or just strengthen DXB and ORD as hubs? Does EW flying DXB-ORD undermine any hub or just strengthen DXB and ORD as hubs? On the contrary, smaller planes have strengthened hubs (they are not flying P-to-P) On the contrary, smaller planes have strengthened hubs (they are not flying P-to-P) 744 to 777 on Pacific (DFW-NRT, ORD-KIX) 744 to 777 on Pacific (DFW-NRT, ORD-KIX) 747 to 763, 757 on Atlantic (EWR-EDI) 747 to 763, 757 on Atlantic (EWR-EDI)

16. The Future of U. S. Network Hubs The solutions? The solutions? Network where the LCCs “aren’t” Network where the LCCs “aren’t” More international supports the domestic network More international supports the domestic network This year: This year: CO EWR-OSL, EWR-EDI CO EWR-OSL, EWR-EDI UA ORD-KIX, SFO-PEK UA ORD-KIX, SFO-PEK The inexorable march of the RJs: The inexorable march of the RJs: 35=>50=>70=>90=>100 seat RJs 35=>50=>70=>90=>100 seat RJs RDU-ORD last week on a 100-seat RJ RDU-ORD last week on a 100-seat RJ RJs vs. the congestion problem: the compromise at ORD RJs vs. the congestion problem: the compromise at ORD

17. It’s the COSTS not the CONCEPT No-brainer, any network carrier can make money at any hub with the right costs No-brainer, any network carrier can make money at any hub with the right costs Efficiency? The rolling hub concept Efficiency? The rolling hub concept WN’s achievement vs. AA’s attempt WN’s achievement vs. AA’s attempt AW&ST: AW&ST: AA Shaved 4 min at hub, 8 min at spoke AA Shaved 4 min at hub, 8 min at spoke Median connecting time extended 7 min, mean much longer Median connecting time extended 7 min, mean much longer 4% loss of market share vs. UA at ORD 4% loss of market share vs. UA at ORD The recipe for monopoly hubs? No hub is a monopoly The recipe for monopoly hubs? No hub is a monopoly

18. Technology is Steadily Attacking Costs The spread of technology helps the legacy carriers as much as the LCCs The spread of technology helps the legacy carriers as much as the LCCs Internet distribution Internet distribution At-home check-in At-home check-in Lobby e-kiosk check-in Lobby e-kiosk check-in In-concourse kiosk rebooking In-concourse kiosk rebooking At-gate bar-code readers, EGR At-gate bar-code readers, EGR Where Have the Lobby Lines Gone? Where Have the Lobby Lines Gone? Crandall’s comment about oil prices Crandall’s comment about oil prices

19. The Real Problem: Legacy not Network We refer to “Legacy Network Carriers” We refer to “Legacy Network Carriers” The problem is: The problem is: The “legacy” The “legacy” Not the “network” Not the “network” Any old corporation unwise enough to create defined benefit pension plans is saddled with them Any old corporation unwise enough to create defined benefit pension plans is saddled with them LTV, Bethlehem Steel LTV, Bethlehem Steel Vs. Defined contribution, 401Ks, profit sharing (in cash, not company stock, a secret of WN) Vs. Defined contribution, 401Ks, profit sharing (in cash, not company stock, a secret of WN) Legacy carriers digging themselves out from outdated union contracts and lease rates. AA most successful by cutting costs out of bankruptcy. Still to come: NW, DL Legacy carriers digging themselves out from outdated union contracts and lease rates. AA most successful by cutting costs out of bankruptcy. Still to come: NW, DL

20. The Future of Network Hub Carriers Escaping the LCC competition, inexorable drive to international routes that can only be fed from a network Escaping the LCC competition, inexorable drive to international routes that can only be fed from a network Whether CO flying to 20 cities in Europe from EWR or to 20 cities in Mexico from IAH with RJs Whether CO flying to 20 cities in Europe from EWR or to 20 cities in Mexico from IAH with RJs Whether UA chipping away at China route rights, next to come, nonstop SF-Guangzhou? Whether UA chipping away at China route rights, next to come, nonstop SF-Guangzhou?

21. Hollowing Out the Middle Current uniformly sized 737, M80 fleets concentrate capacity in 110-140 seat range Current uniformly sized 737, M80 fleets concentrate capacity in 110-140 seat range Too large for domestic, too small for intl Too large for domestic, too small for intl Wave of the future Wave of the future EMB 170, 190 EMB 170, 190 CRJ 70 CRJ 70 Not a happy future for the 737 Not a happy future for the 737 AA reinventing east coast via ERJs with 35, 45 seats (BOS-LGA-PHL-DCA-RDU) AA reinventing east coast via ERJs with 35, 45 seats (BOS-LGA-PHL-DCA-RDU)

22. Legacy Carriers will Hunker Down to Hubs B6 will push AA and UA off transcons except for a few “movie star” routes and international connections B6 will push AA and UA off transcons except for a few “movie star” routes and international connections Big hubs are favored over small hubs Big hubs are favored over small hubs More network connections More network connections More ability to reschedule to rolling banks More ability to reschedule to rolling banks Hubs that may be doomed (too small, no international) Hubs that may be doomed (too small, no international) US in general, esp. PIT US in general, esp. PIT DL at SLC DL at SLC CO at CLE CO at CLE Can AA and DL at JFK survive B6 onslaught? Can AA and DL at JFK survive B6 onslaught?

23. Hubs of the Future Any city with low local traffic generation should look like CVG, with RJ feed Any city with low local traffic generation should look like CVG, with RJ feed Could STL have been saved? Could STL have been saved? Will NW at MEM be viable? Will NW at MEM be viable? Hubs that will be here 20 years from now Hubs that will be here 20 years from now All of these All of these AA at MIA, DFW, ORD AA at MIA, DFW, ORD CO at EWR, IAH CO at EWR, IAH DL at ATL, CVG (but not DFW, SLC) DL at ATL, CVG (but not DFW, SLC) NW at DTW, MSP NW at DTW, MSP UA at IAD, ORD, DEN, SFO (not LAX) UA at IAD, ORD, DEN, SFO (not LAX) US? Silence.... US? Silence....